Scope Ratings AG has today upgraded the Republic of Poland's long-term local-currency rating from A to A+, following the release of its revised sovereign rating methodology, and has converted its status from subscription to public. The agency has also assigned a long-term foreign-currency issuer rating of A+, along with a short-term issuer rating of S-1+ in both local and foreign currency. The sovereign’s senior unsecured debt in local and foreign currency was also rated at A+. All Outlooks are Stable.

Rating drivers

The ratings are underpinned by Poland’s EU membership and the country’s proven economic resilience. Poland is one of the fastest-growing economies in the EU, with very low economic and financial volatility alongside reduced external risks. The rating upgrade is driven by improvements in Scope’s ‘domestic economic risk’ and ‘external economic risk’ analysis categories and reflects: i) Poland’s improving economic prospects along with higher absorption of EU funds; and ii) Poland’s reduced current-account vulnerabilities and increasing external buffers.

Poland’s solid macroeconomic performance with overall annual real GDP growth averaging 3.8% over the last 10 years has been supported by a strong policy framework including a credible monetary policy framework and a flexible exchange rate policy. The economy remains on a robust growth path, although real GDP growth declined to 2.7% in 2016, down from 3.8% in 2015, due to a slowdown in investment. This is explained in part by the temporary effects of the lower absorption of EU structural funds during the transition to the new 2014-2020 EU financial period. Some political initiatives regarding sectoral taxations also hampered planning reliability. However, some of the controversial policy initiatives introduced in 2016 were either withdrawn or had no material negative impact on economic performance. Private consumption has expanded strongly since the second half of 2016 after new social benefits for families were implemented as part of a flagship government programme. Going forward, Scope expects the continuation of solid growth in private consumption, together with a marked recovery in investment, alongside a higher absorption of EU funds, low real interest rates and increasing business confidence, to lead to real GDP growth of above 3.5% in 2017 and 2018.

It is Scope’s view that Poland’s current account vulnerabilities are moderate because of the high quality of funding sources for external deficits. The current-account deficit further narrowed to -0.3% of GDP in 2016 from -0.6% of GDP in 2015. Most of Poland’s recurring current-account deficit is covered by long-term capital inflows in the form of foreign direct investments, intra-company loans and EU structural fund inflows, making it less prone to capital flight during periods of financial market turbulence. Official foreign-exchange reserves swelled by EUR 21bn to reach EUR 108bn in 2016, covering 214% of short-term external debt. In addition, a new two-year Flexible Credit Line arrangement with the IMF amounting to EUR 8.2bn was approved, reinforcing the increased external robustness of the Polish economy.

The ratings are also underpinned by Poland’s continued improvements in fiscal consolidation. The general government deficit decreased to -2.4% of GDP in 2016 from -2.6% of GDP in 2015 (the primary deficit decreased from -0.8% of GDP to -0.7%). The reduction of deficits mainly resulted from a substantial drop in public investment and, to a lesser extent, from improved tax collection. Long-term budgetary pressures are increasing, however, as the government has stepped up spending on higher pensions, child benefits and public-sector salaries. Though the current fiscal stance is roughly neutral, the budget deficit is expected to widen to 2.9% of GDP in 2017 due to rising social benefits. The government is committed to maintaining a deficit below 3% of GDP and to start fiscal consolidation in 2018.

Poland’s public debt is moderate but sustainable. General government debt increased from 51% of GDP in 2015 to a still-moderate 54.4% in 2016 (equivalent to public debt of 52.1% according to the national definition). Scope assesses Poland’s public-debt dynamics as adequate because of their relative robustness across a number of plausible scenarios over the projection period to 2022 as well as in view of a constitutional public-debt brake mechanism in place pressuring public debt does not exceed 60% of GDP. Potential deviations from fiscal targets are limited by expenditure rules including correction mechanisms which adjust expenditure growth if public debt-to-GDP exceeds 43% and 48% thresholds, and additional prudential procedures if the public debt-to-GDP ratio breaches a 55% limit. Borrowing requirements have been reduced as a result of centralised liquidity management and an obligation on certain public-sector entities to place their liquid deposit funds with the Ministry of Finance. The amount of funds deposited amounted to approx. PLN 40bn at the end of 2016.

Scope expects that debt-to-GDP will gradually decrease over its forecast period to 2022, as robust economic growth and low financing costs offset the relatively small but sustained debt-creating effects of primary deficits. Given sizeable external financing needs, external risks could threaten public debt dynamics, but should not place them on an unsustainable trajectory. International investor interest in Polish bonds is significant, in particular for long-term maturities. The share of foreign-currency-denominated debt in state treasury debt decreased from 34.9% in 2015 to 34.4% in 2016. According to Poland’s debt management strategy, the country expects to meet its target of lowering foreign-currency-denominated debt to below 30% by the end of 2019, while also maintaining a strategic share of euro-denominated debt in the foreign-currency-denominated basket of at least 70%.

The banking sector remains liquid and well capitalised and has successfully absorbed the new bank asset tax effective since February 2016. Swiss-franc-denominated mortgage loans pose a key risk, as the potential costs imposed on banks could limit credit extension. The government backed down from a previous mandatory proposal to convert these loans into PLN. New proposals point to a voluntary mechanism incentivising banks to convert foreign-exchange mortgages over time, significantly reducing potential costs for banks compared with the original proposal.

Despite its resilience, the Polish economy faces several challenges. While the short- to medium-term economic growth outlook remains strong, long-term growth prospects are more subdued, given demographic headwinds, low private investment, regional disparities and slow productivity growth. The working-age population has been falling by 1% annually since 2012, with the result that skilled labour shortages have been rising steadily. The labour participation rate has remained at 56% since 2012, which is low, and is likely to decline further in view of the reduction in the retirement age, to become gradually effective from Q4 2017 on (a further flagship programme).

Ongoing political and policy uncertainty is set to continue. The new government has controversially placed judges loyal to the government in Poland’s constitutional court and is planning to do so with other courts. Tensions with the EU over the European Commission’s ‘Rule of Law’ procedure are ongoing, and the risk of sanctioning mechanisms (which would result in a reduction in EU voting rights and/or sanctions) has not dissipated. Scope does not expect the strained relations with the EU to have a material negative effect on economic conditions.

Sovereign rating scorecard (CVS) and qualitative scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative A (a) rating range for the Republic of Poland. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis. For the Republic of Poland, the following relative credit strengths have been identified: i) the growth potential of the economy; ii) the economic policy framework and; iii) market access and funding sources. Relative credit weaknesses are: i) vulnerability to short-term shocks; and ii) recent events and policy decisions. The combined relative credit strengths and weaknesses indicate a sovereign rating of A+ for Poland. A rating committee has discussed and confirmed these results.

For further details, please see Appendix 2 of the rating report.

Outlook and rating-change drivers

The confirmation of the Stable trend reflects Scope’s view that risks to the ratings remain broadly balanced.

The ratings could be downgraded if: i) the political conflict with the EU regarding the rule of law escalates to a level that would result in possible sanctions; ii) Poland experiences a protracted period of low growth as a result of under-absorption of EU funds; iii) investor sentiment worsens leading to a material weakening in market access; iv) fiscal slippages or circumventions of the institutional public-debt brake mechanism undermined public debt dynamics. The ratings could be upgraded if: i) growth potential increases on the back of structural reforms; ii) investments accelerate, owing to improved and more stable business policies; or iii) sustained consolidation leads to a steady and more rapid reduction in public debt.

For the detailed research report, please click here.

Rating committee

The main points discussed by the rating committee were: i) Poland’s economic outlook; ii) fiscal performance and debt sustainability, based on a strong and conservative policy framework; iii) external position and vulnerability to short-term shocks; iv) the reliance on foreign direct investment; v) recent political developments and vi) peers comparison.

Methodology

The methodology applicable for this rating and/or rating outlook ‘Public Finance Sovereign Ratings’ is available on www.scoperatings.com.

The historical default rates used by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/governance-and-policies/regulatory/esma-registration. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.

The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months. A rating change is, however, not automatically a certainty.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.

Rating prepared by Jakob Suwalski, Lead Analyst

Person responsible for approval of the rating: Karlo Stefan Fuchs, Executive Director

The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The subscription ratings/outlooks were last updated on 05.05.2017.

The senior unsecured debt ratings as well as the short term issuer ratings were assigned by Scope for the first time.

As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Republic of Poland are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 21.07.2017 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent placement of the ratings under review, in order to conclude the review and disclose these ratings in a timely manner, as required by Article 10(1) of the CRA Regulation.

Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.

The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: the Ministry of Finance of the Republic of Poland, Central Bank of Poland, European Commission, European Central Bank (ECB), Statistical Office of the European Communities (Eurostat), IMF, OECD, and Haver Analytics.

Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.

Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability
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